Laffer’s Ideas Still Relevant — The Phrase “Shared Sacrifice” Still Among The Most Terrifying

Earlier this week, economist Arthur Laffer wrote an Op-Ed piece in the Wall Street Journal condemning a proposal to implement a new 5% state income tax in the state of Washington. (Washington State currently has no state income tax.)

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The creation of the tax is supported by Bill Gates Sr., father of the billionaire software entrepreneur, and a prominent retired attorney in his own right. Laffer’s response to Gates senior: If you want to help the state of Washington with its financial woes, you and your son should write them a check — but don’t impose a tax on everyone else.

While on its face Laffer’s remark may seem like just a witty retort, his piece is extraordinarily data driven: He maps out the case for how states with high income taxes lag, on a relative basis, states with lower or no income tax.

“In the past decade, the nine states with the highest personal income tax rates have seen gross state product increase by 59.8%, personal income grow by 51%, and population increase by 6.1%. The nine states with no personal income tax have seen gross state product increase by 86.3%, personal income grow by 64.1%, and population increase by 15.5%.”

“It's striking how the high-tax states have underperformed relative to those with no income tax. Especially noteworthy is how well Washington has performed compared to states with no income tax.”

“Over the past 50 years, 11 states have introduced state income taxes exactly as Messrs. Gates and their allies are proposing—and the consequences have been devastating. “

As most of us remember from our college economics classes, the Laffer Curve is a kind of thought experiment. The curve seeks to demonstrate the elasticity between tax rates and tax revenue.

Unlike some concepts in college macroeconomics, the Laffer Curve is both devilishly simple and oddly compelling: At a tax rate of zero, the government generates no tax revenue; and on the other extreme of the curve, at a 100% tax rate, the government also generates no tax revenue — because why would anyone want to work if you didn’t get to take home any pay? ( Of course, the Soviets found an ingenious solution to an effective 100% tax rate: de facto slave labor — and prison sentences for the slackers. To their credit, the Soviet model has yet to gain serious traction among the academic left in the U.S.)

Of course, supply side tax theory can be carried to an extreme. And it’s always seductive to believe you can have your cake and eat it too. (Who doesn’t want increased productivity, higher net pay, and increased tax receipts?)

But while the Laffer Curve is sometimes parodied as the prime example Voodoo Economics, you don’t need to be a terribly deep economic thinker to see the point that tax receipts fall off on both sides of the apex. The Laffer Curve doesn’t argue that cutting taxes always increases tax revenue: Think parabola — not asymptote.

There is, of course, a theoretical Gladwellian tipping point. And Laffer’s Op-Ed in The Journal reminds us that there is more to economic policy debate than elegant economic thought experiment — there is actual historical data. So when an eloquent guy in a blue suit talks of how “shared sacrifice” contributes to the greater good, ask him for his numbers.